Solid U.S. retail sales renew concerns of a potential interest-rate increase by the Fed next month

Investors stepped out of the shelter of U.S. government debt Thursday for the first time in three days as anxiety over the global growth outlook dialed back.

Riskier assets stabilized after being rattled by worries over China’s economic growth over the past two days. A solid retail sales report Thursday pointed to an improving U.S. economy, bolstering the case for the Federal Reserve to raise short-term interest rates next month.

“We are back to looking at the U.S. economy and it looks healthy and moving quickly to meet the Fed’s goals for employment and growth,” said Thomas Roth, executive director in the U.S. government bond trading group at Mitsubishi UFJ Securities (USA) Inc. in New York. “Unfortunately the rest of the world is not so good so it is hard for the market to determine how it all adds up in Fed Chairwoman Janet Yellen’s head.”

In late-afternoon trading, the yield on the benchmark 10-year Treasury note was 2.189%, compared with 2.134% on Wednesday, which was the lowest closing level since May 29. Yields rise as prices fall.

A $16 billion sale of 30-year Treasury bonds drew average demand on Thursday, contributing to price weakness in the bond market.

Investors had sought safety in ultrasafe Treasury debt after China on Tuesday surprised investors by devaluating its currency, which heightened concerns over the world’s second-largest economy and its potential ramifications globally.

Thursday, anxiety in global financial markets dialed back after Chinese central bank officials ruled out a significant decline in the yuan and said that China has the financial firepower to defend the currency as needed.

Customers browse at a J.C. Penney Co. store in Brooklyn, N.Y. this month. New data on retail sales Thursday showed an improving U.S. economy, leaving the door open for the Fed to raise rates in September.
Photo:
Michael Nagle/Bloomberg News

Meanwhile, U.S. retail sales rose a seasonally adjusted 0.6% in July from a month earlier, the Commerce Department said Thursday. Excluding cars, sales rose 0.4% in July, the third consecutive month of solid gains.

“A rate hike in September is still on the table,” said Gene Tannuzzo, senior fixed-income portfolio manager at Columbia Threadneedle Investments, which has $503 billion assets under management.

Mr. Tannuzzo said the Fed could act next month since he is skeptical that developments in China would have a material impact on the U.S. growth outlook or financial conditions. He has sold Treasury debt from the recent rally and invested into high-grade corporate bonds, which offer more attractive yields.

Fed funds futures showed on Thursday that investors and traders see a 45% likelihood of a rate increase at the September meeting, up from 39% on Wednesday, according to data from the
CME Group.

The yield on the two-year note, among the most sensitive to changes in the Fed’s interest-rate outlook, was 0.709%, compared with 0.657% on Wednesday. The yield is trading near the highest level of the year.

Many investors aren’t convinced that the U.S. economy is strong enough for the Fed to raise rates. They are worried that if the central bank increases rates prematurely, it could hurt the U.S. growth outlook.

U.S. long-term bond yields have tumbled this quarter after a rise between April and June, as investors and policy makers world-wide grapple with sluggish global economic growth, plunging commodities prices and very low inflation.

Lower Treasury yields are confounding many investors and analysts who had expected the 10-year yield to rise toward 3%. The prospect of higher interest rates from the Fed, they have said, would shrink the value of outstanding bonds whose prices had climbed in recent years thanks in part to the Fed’s monetary stimulus.

One boost for demand for long-term bonds has been tumbling oil prices which reduced inflation expectations. U.S. crude-oil prices on Thursday dropped below $42 a barrel intraday for the first time since 2009. A gauge of 10-year inflation expectations in the Treasury debt market fell to the lowest level since January. Inflation is a main threat to the value of long-term bonds.

A weaker Chinese yuan has sent many emerging-countries currencies falling and has pushed the dollar higher. A stronger dollar hurts the U.S.’s competitiveness in global trade, while reducing the prices of imported goods.

There are “growing global deflation risks,” which attract buyers into long-term bonds, said Bob Andres, founder and chief investment officer of Andres Capital Management, which has more than $100 million in assets under management.